Some Chips Investors Shouldn't Cash In

One niche in the semiconductor sector worth watching is the programmable-logic industry. Earnings for the big players were very good in the quarter just ended. More important, though, the futures of a number of companies that manufacture these chips continue to show abundant promise.

First Things First: Earnings
Xilinx  is currently the trailblazer in programmable logic devices (PLDs). The company's most recent product family is seeing extremely strong demand in the communications industry. What's more, the company's sales and earnings are growing like gangbusters, as demonstrated by fiscal fourth-quarter results, reported Thursday evening. Xilinx reported earnings per share of $0.22 before investment gains, which was a penny higher than expectations. Overall growth was 16% over the December quarter and more than 65% over the same quarter last year.

Earnings from the other two primary players in the PLD industry weren’t exactly shabby, either. Altera  reported first-quarter per-share earnings that were $0.02, or 6%, ahead of expectations. Both sales growth and margins were also very good. Sales, for example, grew by 15% over the December quarter and almost 60% over the same quarter last year. The company generated a favorable portion of its sales from its newest products. The firm’s chip supplies are somewhat constrained, but the company should catch up with the strong demand in the communications sector as it increases production of its newer products.

Lattice Semiconductor's (LSCC) earnings in the quarter just ended were also strong. The company reported earnings before goodwill of $0.52 per share, 6% ahead of expectations. Lattice saw strong growth in the quarter, as sales increased by 10% over the fourth quarter of 1999. Management increased its sales-growth target on the year from about 25% to about 30% to 35% in fiscal 2000.

The Nitty-Gritty on PLDs
So what's all the hubbub over programmable-logic chips?

Programmable-logic chips are different than most other semiconductors because the end user can customize them. In a fast-changing industry, such as the data-networking sector, there's an obvious advantage to using a programmable chip. PLDs allow customers to bring their products to market quicker, which is important in gaining a fast lead in a new product area. As PLDs continue to decrease in price and improve in performance, they are becoming more attractive to customers that would have otherwise used a preprogrammed chip. Technological improvements in PLDs are creating more demand for the chips, above and beyond the already-strong growth in the communications industry.

Altera and Xilinx are clearly the industry leaders, with Xilinx holding a slight lead in market share because its product family is an industry juggernaut thus far. Altera isn’t all that far behind, however, and there’s no compelling reason to suggest that either company will significantly pull ahead of the other in the long term. Lattice, on the other hand, would be considered a second-tier player because its chips don't have the same high-growth exposure in the industry.

Expensive, but a Decent Long-Term Bet
Not surprisingly, the valuations of Xilinx, Altera, and Lattice are all fairly steep, given the recent excitement over expected growth in the communications industry. Lattice is the cheapest of the bunch, but justifiably so since it doesn’t have the same growth prospects. Still, the company is the value way to play the industry. Altera trades at a significant discount to Xilinx on the basis of current price/earnings multiples. It's foreseeable that this discount will narrow as Altera's newest family of products hits full stride.

On the whole, the PLD makers are somewhat cheap relative to most other chip companies with similar exposure to the communications sector. Moreover, both Altera and Xilinx are very profitable companies; the margins of PLD makers tend to be higher than the average company in the chip sector. With fabulous earnings-growth potential and the trend of wider use in nontraditional applications, the PLD industry is worth a lot of attention.